51% of contract managers say that payment terms have become a more contentious issue in their negotiations, with many smaller companies under pressure to accept longer payment periods. Overall, 70% of companies say that they have adjusted their standard payment terms during the last 2 years.
In a recent IACCM survey, 18% of major corporations (those with over $40bn annual revenue) acknowledge that they now pay suppliers on 90 day (or more) terms. This compares with just 5% of smaller companies (revenue up to $10bn). Larger corporations are also more likely to impose ‘early payment discounts’.
40% of smaller companies report that more onerous payment terms are being imposed on them by their customers. This compares with just 22% of large corporations facing the same pressure. There is universal agreement that the main factor determining acceptance of these provisions is negotiating power (59%), followed by ‘the nature of the relationship’ (43%). Just 25% say that they vary terms based on geography or market segment – pointing to the trend towards universal consistency.
However, important regional variations remain in place. For example, in the US, the trigger for invoicing often remains ‘shipment’ – a concept rarely used elsewhere. In the Middle East, Africa and Asia, there is a greater tendency to invoice on acceptance and for the payment period to commence on receipt of invoice – but these more generous terms are accompanied by 30 days remaining the norm for the payment period.
Smaller companies also experience greater difficulty in getting paid. 77% say that customers typically adhere to the payment terms, whereas this rises to 92% for large corporations.
The survey also revealed that European companies are the most likely to use outsourced payment centers, with 20% making use of such services, versus 15% in the United States and just 9% in Asia.
The reasons for extensive negotiation immediately become apparent when comparing the standard positions of buyers versus sellers. For example, 67% of suppliers still attempt to operate on 30 day terms. Just 16% of suppliers include early payment discount in their contracts, whereas 40% of customers seek such discounts. When it comes to charges for late payment, the position is of course reversed – with 60% of suppliers seeking such terms and 29% of buyers accepting them.
Many of those surveyed do not expect any reduction in the pressure on payment term negotiations. They anticipate that businesses will continue to see extended payment as a mechanism to enhance cash flow; they also anticipate increased levels of factoring / supply chain finance; more discounts for early payment; and continuing standardization across business units.
The IACCM survey was conducted in March/April 2015 and gathered input from almost 600 corporations. Full results will be issued by the end of April.
Last week, one of my blogs included observations on the way that attitudes to contracts are changing. In response, drafting guru Ken Adams challenged my suggestion that these shifting attitudes will lead to fundamental changes in contract design. I think his implication is that change, to the extent it happens, will not significantly impact contract structure, but will simply move from undisciplined pedantry to an alternative and more rigid style of authoring, based on his style guides.
The challenge is valid. Legal form is long established and the profession is slow to change, especially in areas where the resulting benefits are uncertain. So on what basis do I believe that change will occur?
There are a number of dynamic forces:
- Social pressure – people are demanding greater clarity. Indeed, even the CEO community now believes that a reputation for honesty and integrity is fundamental to business success and this is affecting approaches to terms and conditions..
- Generational pressure – new approaches to communication, intolerance of complexity New technologies and media have resulted in the expectation that communication is clear and honest.
- Technology – analytics are demonstrating the relative importance of different risks and the consequences of those risks. High among them: inefficiency and ineffectiveness of ‘traditional’ contracts which then damage financial performance.
- Pressure on lawyers to perform – as with medicine, there is an increasing focus on prevention – from contracts as a source of risk to contracts that manage risk.
So those are among the forces. Where is the evidence that this is actually leading to change? Here are some examples. Law schools, even law firms, are now actively working on new approaches to contracts based on artificial intelligence and the need for machine readable data. General Counsels are wanting to know the precise link between contract terms and economic impacts. Cross-industry groups are working to establish industry standards and to escape the inefficiencies and delays created by the ‘battle of the forms’. In-house legal groups increasingly appreciate their role is to enable the business, not to sit in judgment on it. There is growing acknowledgement that recourse to the courts is no longer relevant for many forms of agreement and therefore strict ‘legalese’ is unnecessary. Then there is the fact that other complex documents – such as engineering drawings – are moving into the virtual world and in the process discovering that such a move saves time and money. Finally, law schools are starting to include practical programs about contracts and contract management, preparing future lawyers to work in business, not in the courts.
Ultimately, change is most often driven by economics. And the economic case for new approaches to contracting is becoming more evident and is compelling. I understand that from where Ken sits, the pressures – and reactions to them – may be less visible. Ultimately, even something as traditional and formalized as contracts cannot stand in the way of progress.
“We must think about contracts as the foundation for business operations”, observed Steve Harmon, Deputy General Counsel at Cisco. “We’ve reached the end for strategic ambiguity in contracts – there is a need for far more clarity”.
Steve, along with Paul Lippe, CEO of LegalonRamp, was a presenter on a recent IACCM webinar exploring the implications of the new ASC606 revenue recognition standard, due to be implemented in the US (a recording is available in the IACCM member library).
The standard is significant in that it is just one more step forcing organizations to have clarity and precision in their contracts, enabling unambiguous data extraction and management. The regulation forces organizations to unbundle their contract obligations and take revenue only as each obligation is fulfilled. That means contracts staff must be far more aware of the various cost elements within a contract and to ensure there is not only clarity within the terms, but that relevant commitments and obligations are then flowed into the business and actively monitored.
This requirement simply reinforces the existing pressures for better designed contracts and for robust processes supporting data extraction, dissemination and monitoring. It plays to existing trends – such as offshore centers to undertake extraction, more sophisticated contract management systems, growing focus on the role of ‘contract owners’. As Steve Harmon also observed when talking about CLM applications: “We need to publish the implications of contract terms, not just simplify their creation”.
In summary, we are looking at contracts and their management becoming a core capability for businesses, rather than a peripheral area of administration. Contracts have been obscure, yet now they must be increasingly transparent and designed for active use. These are challenging changes for all the professionals traditionally involved in their creation and management. The pervasive nature of contract terms means that many people in the business are affected. Indeed, just yesterday I was writing an article for a Sales journal, explaining the impacts on the traditional sales and account management teams.
Over the next two years, we will see a fundamental reappraisal of contract design and wording, challenging the way that traditional legal drafting has occurred. We will see fundamental changes in the software to support contract management, as artificial intelligence and machine readable data facilitate extraction and dissemination of information. We will see fundamental changes in the way that contract portfolio performance is monitored and business intelligence is generated to drive marketing and policy decisions, as well as far greater sophistication in understanding and managing risk. And this means we will without doubt see fundamental changes in the way that contract management skills are developed and deployed.
As part of the mounting social debate over ethics and perceived fairness, the UKs Labour Party has announced that suppliers to the National Health Service will not be permitted to make more than 5% profit.
The intent here may be to ensure the exclusion of private business from health services, but that would seem to lead to their inevitable collapse, since there is complete dependency on the private sector for drugs and equipment. So perhaps it is simply a target number, or a way to impose price pressure at a time when current procurement practices have largely stripped the fat from supplier pricing. Most likely, it is just unattainable populist politics.
But behind the headline is a serious issue and that is around the growing questions over ‘permissible’ levels of profit. This is a complex area, since profits – and the need for them – vary dramatically. Commodity businesses, with low costs of entry, constantly struggle to make or maintain margin; many retail sectors are a case in point. Such sectors are often under public and political pressure to mimimize prices, yet often the only ways they can do this are either by cutting service levels or pressuring their own (often small) suppliers. In both cases, they are then criticized by those same people who demanded the lower price. Another example is utilities, where true competition is often difficult to achieve because of the underlying monopoly in infrastructure. Again, prices in this industry are a political football, since everyone needs access. Companies in the energy industry struggle to make profit and are then accused of failing to make investments in the infrastructure and supply network. Today, many energy companies can make more money by helping customers use less energy than they can by selling them the energy itself.
To add to the irony of the situation, recent research discovered that consumers actually accept being ‘ripped off’ by their favorite brands, so long as there is transparency in pricing! It is certainly notable how little pressure there is on a company like Apple, despite its remarkable profitability and cash pile. This leads us to another aspect of modern pricing, which is the issue of open-book accounting. Certainly it is a focus for Governments. Yet once again, even if socially desirable, the formula is complicated. The definition of an acceptable margin must take account of circumstances. For example, price should bear a direct correlation to risk. It should also link to the potential for innovation and investment. And for a multi-project supplier, should margin be limited on each project, or across the entire portfolio?
One thing seems certain: debates on pricing and on the morality of profit are unlikely to go away. The digital age means that every business has to live with increased visibility and needs to accept that it will face demands for greater transparency and for justifications of its pricing policies.
‘Just because you can doesn’t mean you should’ …. That is a principle which every organization should apply when developing its terms and conditions and underlying business policies.
It certainly seems to be the case in the recent announcement by Amazon that it will no longer require contract staff to sign non-compete agreements (at least in the UK). Many of these workers are on minimum wage and on variable hours. The inequity of such a term should surely have struck any fair-minded executive at Amazon and resulted in such a provision never being imposed. But it did not – and this calls into question the internal review process for policies and contract provisions.
According to a recent study of European CEOs, ‘honesty and integrity’ are today’s most important attributes for business. They may well be right, since public and political opinion is increasingly hostile to what is seen as unfair and manipulative behavior by many large corporations. Examples abound – for instance on issues such as payment terms, rights of termination and ownership of intellectual property. Amazon is certainly not alone in using its power to impose one-sided contracts.
It sometimes seems as though companies take the view that if there isn’t a regulation prohibiting it, any action is acceptable. But of course it is not – and this points to a key failing in many organizations today: a lack of judgment.
This issue of judgment is not new, but it is increasingly complex. Our interconnected world, the growth of specialism, the shift in public and political expectations have combined to multiply the range of stakeholder views that must be taken into account. At the same time, functional silos within business have made it increasingly difficult to reach balanced decisions on a timely basis.
It is this set of dynamics – and the need to project ‘honesty and integrity’ – that underpins growing interest in ‘commercial acumen’. Organizations need their staff to have greater awareness and sensitivity to the potential consequences of their actions. Those who prepare or draft such terms must, in particular, be a last line of defense and ready to challenge the wisdom of the policy sponsor. For those in procurement, contract management or legal, the opportunity is clear: it is time to have the courage to demonstrate capacity for judgment.
So Microsoft now requires its suppliers to commit that their workers in the US receive a guarantee of paid leave. This requirement will apply to all employees who do ‘substantial work’ for Microsoft.
This announcement has a number of fascinating implications – and reinforces my past blogs suggesting that the contract and commercial management community need to start taking sustainability issues far more seriously.
First, I was interested to note that it was Microsoft’s General Counsel, Brad Smith, who made this announcement. It’s not the sort of issue that would typically have been associated with the Legal function – but this is just one indication of how fast the role of in-house legal is altering.
Second, the broader rationale for this move is to enhance (or protect) Microsoft’s reputation in an environment of growing public hostility to Corporate ethics and practices, especially in matters of finance and income distribution. So expect much more of this type of initiative, as others jump onto the bandwagon and try to build their reputation. What might come next? Perhaps push-back on zero hours contracts, or demands that workers receive health coverage, or insistence on specified minimum wages? And issues around ‘ethical practices’ won’t stop there. What about caps on executive compensation, or limits on employee bonuses, or elimination of tax arrangements that are viewed as ‘unfair’?
Third, just think of the practical issues associated with implementing and managing the Microsoft requirement. Even if there is agreement on what constitutes ‘substantial work’, can suppliers really start to differentiate among their employees in this way? Issues of morale, employee relations and potentially litigation would suggest that Microsoft suppliers will have little choice but to change policy for all their US employees. And can they limit geographically? Indeed, can Microsoft justify the geographic limit to US workers?
Microsoft say that they recognize the potential cost impact of this change and are willing to negotiate with suppliers accordingly. Other customers may not be so happy to follow suit. So that leaves a supplier wanting either to pass all resultant costs onto Microsoft, or of having to accept a potential hit on margins. It will be interesting to discover how Procurement at Microsoft has been instructed to deal with these situations and in what way their measurements are being adjusted; for example, will Procurement continue to be measured on savings, or increasingly on maintaining corporate reputation?
Finally, if you think this move will be complicated to manage, just imagine what it will be like when others start jumping on the bandwagon. There is little point in them following the Microsoft approach – it is no longer newsworthy. So each initiative needs to have originality – and imagine for a moment what that could mean for suppliers. How can they possibly manage in a world where individual customers start to set rules for personnel policies and broader business practices. For example, Oracle may now say they don’t want to deal with suppliers who avoid taxes through offshore operations (unlikely I know, but I use it simply as an example).
As the Corporate world awakens to the need to rebuild public trust, we have to anticipate a mass of sustainability initiatives – and it is hard to see how they can be achieved without significant cost and price increases.
Procurement, legal compliance, accounting, marketing … These are all necessary activities within a business. The problem comes when those activities become enshrined within rigid policies and practices which are not well aligned and then undermine business goals and performance.
A recent report from Deloitte illustrates this point perfectly. It is just the latest in a number of audit reports that highlight how procurement practices damage economic results, frequently overwhelming the declared ‘savings’ that are generated by today’s Procurement functions. Yet when you review the causes identified by the study, most Procurement groups would deny responsibility: the problems are associated with poorly defined objectives, unbalanced allocations of risk …. ‘Not my job’ will be the reply. ‘That’s because of senior management, engineers, lawyers ….’. And in fairness, they are right – because the real problem is that process responsibilities are not aligned and the business lacks holistic insight.
This immediately illustrates the point that we must distinguish competency to perform a task from the assumption that it will then be achieved by a specialist business function. Firstly, the job title frequently does not reflect the span of responsibility. Secondly, there is a very real danger that the specialists become a barrier to good performance because their practices become sacrosanct, rather than the quality of their output.
Output is often hard to define and measure. You need to find critical indicators. That is why IACCM promotes the idea of measuring contract performance. Contracts are, after all, tangible assets – far more so than the sales revenue forecasts or procurement savings that are such a focus today. Smart organizations take these predictions of contract performance and monitor the actual results. More importantly, they explore and analyze the reasons behind performance gaps.
Contracts represent an overall measure of business effectiveness since every activity within the business contributes to them. If looked at through the lens of the contract, almost any shortcoming – or success – can be tracked back to its origin. This analysis, when the results are considered, quickly starts to reveal the practices and processes that are out of step with business needs – or which should be promoted to ensure success.
Increasingly, analyses are pointing to issues like insufficient stakeholder engagement, selection of the wrong supplier, use of the wrong incentives, inappropriate allocations of risk, over-commitment of resources …. All of these are readily evident from analysis of contracts that fail or underperform. Yet rarely are such analyses undertaken. Why? Ironically because contracting is one area where there is rarely a defined process and even more rarely any point of accountability for overall performance. While individual contracts may have ‘owners’, these unfortunate people typically do not receive substantive guidance or support. Indeed, the contract they are handed is frequently flawed from the outset due to the various policies and practices that governed its construction .
‘Commercial excellence’ is a term that every business leader should adopt. They should see this in terms of whether their organization’s contracts are delivering intended results. They should be demanding insights to the causes of under or over-performance. Essentially, business leaders need a small team that undertakes forensic analysis into business policies and practices as they relate to performance on contracts. Their key target should be to drive incremental revenues and cost reduction through improved performance of the contract portfolio.